March Madness for Cyprus

by Shawn Narancich, CFA Vice President of Research

March Madness

With Italy still lacking a government after indecisive elections earlier this month and business on the island of Cyprus grinding to a halt because of a banking crisis there, Europe is again proving to be a thorn in the side of investors. Blue chip stocks were stirred but not shaken, ending the week modestly lower amid an uptick in volatility. Because Cyprus is a tiny economy with a total GDP a tenth of a percentage point the size of ours, one could easily dismiss the turmoil there as inconsequential if not for the otherwise surprising proposal by Europe’s power brokers, who recommended that a bailout funded by the European Central Bank, the European Commission, and the International Monetary Fund be accompanied by a tax on Cypriot bank deposits. 

Penny-Wise and Euro Foolish?

The fear is that a bank deposit levy could wash up on the shores of countries like Greece or Italy, where funding bailouts has left a bitter taste in the mouths of German citizens who would like to stop funding the profligacy of southern Europe. The situation in Cyprus is unique because its banking sector is almost entirely financed by deposits. With relatively little funding from bond investors, recapitalizing the oversized Cypriot banks by restructuring debt obligations wouldn’t accomplish much. So following a unanimous rejection of the European proposal, the ball is now in Cyprus’s court, and the shot clock is about to expire. If Cyprus fails to propose a Plan B acceptable to European lenders by Monday, the ECB has promised to eliminate lender-of-last resort funding for the Cypriot banks. With depositors chomping at the bit for their cash, a lack of central bank liquidity would almost assuredly sink Cyprus’s banks once they re-open, and likely lead to the country’s exit from the European Union. Yes, Europe remains a simmering menace to investors. Amid the turmoil this week, Treasuries caught a safe-haven bid that dropped the benchmark 10-year yield back below 2 percent. 

Just Did It

While Europe festers, Nike is prospering. Much to the delight of its shareholders, the sports apparel and footwear behemoth re-energized its stock by reporting better-than-expected sales and earnings that grew at the fastest rate in recent memory. After struggling with excessive inventories and upstart competition in China, Nike “checked all the boxes” this time around, reporting a healthy increase in gross margin profitability and a 7 percent increase in futures orders, including gains from the Red Giant.  On heavy trading volume, the stock raced ahead by 11 percent.

Just Didn’t

Contrast Nike’s success with a disappointing setback for Oracle, which reported February-ending financial results that fell short of estimates both on the top and bottom lines. In what appears to be a case of three steps forward and two steps back for the leader in enterprise software, management cited a lack of follow-through by the sales force, newer members of whom failed to close deals in a timely matter. After quarter end, Oracle booked several of these large deals, so bulls on the stock are left to expect that the financials will look better in Oracle’s seasonally strongest May quarter. Bears will argue that software as a service delivered over the Internet is denting Oracle’s business, but the company’s acquisition strategy has targeted many such “cloud” computing firms to strengthen its capabilities in this area. Meanwhile, the jury is still out on Oracle’s acquisition of Sun Microsystems, with hardware sales from this business continuing to fall. Also on heavy trading volume but with a much different result, Oracle shares fell nearly 10 percent on the news.

Our Takeaways from the Week

  • Stocks remain well bid amid renewed turmoil in Europe
  • Odd-month earnings reports were decidedly mixed